1. The Market Forces of Supply and Demand4
The Market Forces of Supply and Demand

2. Markets and Competition
A group of buyers and sellers of a particular good or service
Can be highly organized
E.g.: agricultural commodities (futures markets)
Can be less organized
E.g.: ice cream, espresso carts, Freemont Sunday market

3. Figure 3.1 The Circular Flow of Economic Activity
Copyright © 2006 Pearson Addison-Wesley. All rights reserved.

4. The Circular Flow of Economic Activity

5. Simplifying the Model
Demand
Supply

6. Markets and Competition
Market Types
1. Perfect Competition
No individual buyer/seller has a significant influence on market price
2. Monopoly
Single producer of good; chooses output (quantity supplied) that max’es profit
3. Oligopoly
Small number of suppliers; may “collude” to set price like a monopolist
4. Monopolistic Competition
Compete on both price and quality against several producers

7. Markets and Competition
Perfectly competitive market
Each buyer/seller has a negligible impact on market price
Why? (Key assumptions)
Goods offered for sale - exactly the same
Buyers and sellers – numerous
No single buyer or seller has any influence over the market price
Must accept the price determined on the market
Price takers
At the market price
Buyers - buy all they want
Sellers - sell all they want

8. Demand Basic Vocabulary Quantity demanded Demand
Amount of a good purchased at a given price
A point on the demand curve
Demand
The entire schedule (curve)
Quantity demanded at various prices
Difference between a change in quantity demanded and demand
Movement along the Demand Curve (change in price) versus movement of the D Curve

9. Demand Demand schedule - a table Demand curve - a graph
Relationship between
Price of a good
Quantity demanded
Demand curve - a graph
Individual demand vs Market Demand
One individual vs all people in buying the good

10. Catherine’s demand schedule and demand curve1
Catherine’s demand schedule and demand curve
$3.00
2.50
2.00
1.50
1.00
0.50
Price of
Ice-Cream
Cones
1. A decrease
in price . . .
Demand curve
Price of
Ice-cream cone
Quantity of
Cones demanded
$0.00
0.50
1.00
1.50
2.00
2.50
3.00
12 cones 10 8 6 4 2
increases quantity
of cones demanded. 12 10 11 9 1 2 3 4 5 6 7 8
Quantity of Ice-Cream Cones
The demand schedule is a table that shows the quantity demanded at each price.
The demand curve, which graphs the demand schedule, illustrates how the quantity demanded of the good changes as its price varies. Because a lower price increases the quantity demanded, the demand curve slopes downward.

11. Demand Market demand Market demand curve
Sum of all individual demands for a good or service
Market demand curve
Sum - individual demand curves horizontally
Total quantity demanded of a good varies
As the price of the good varies
All other factors that affect how much consumers want to buy are hold constant

12. Market demand as the sum of individual demands (demand schedule)2
Market demand as the sum of individual demands (demand schedule)
Price of ice-cream cone
Catherine
Nicholas
Market
$0.00
0.50
1.00
1.50
2.00
2.50
3.00 12 10 8 6 4 2 + 7 5 3 1 = 19 16 13
The quantity demanded in a market is the sum of the quantities demanded by all the
buyers at each price. Thus, the market demand curve is found by adding horizontally
the individual demand curves. At a price of $2.00, Catherine demands 4 ice-cream
cones, and Nicholas demands 3 ice-cream cones. The quantity demanded in the
market at this price is 7 cones.

13. Market demand as the sum of individual demands2
Market demand as the sum of individual demands
Catherine’s
demand +
Nicholas’s
demand =
Market
demand
$3.00
2.50
2.00
1.50
1.00
0.50
Price of
Ice
Cream
Cones
$3.00
2.50
2.00
1.50
1.00
0.50
Price of
Ice
Cream
Cones
$3.00
2.50
2.00
1.50
1.00
0.50
Price of
Ice
Cream
Cones
DCatherine
DNicholas
DMarket 12 10 11 9 1 2 3 4 5 6 7 8
Quantity of Ice-Cream Cones 1 2 3 4 5 6 7
Quantity of
Ice-Cream Cones 18 2 4 6 8 10 12 14 16
Quantity of Ice-Cream Cones

14. Demand Shifts in demand Increase in demand Decrease in demand
Any change that increases the quantity demanded at every price
Demand curve shifts right
Decrease in demand
Any change that decreases the quantity demanded at every price
Demand curve shifts left

15. Appendix Graphs of Two Variables
Taking into Account More Than Two Variables on a Graph
FIGURE 1A-5
Showing Three Variables on a Graph

16. Shifts in the demand curve3
Shifts in the demand curve
Price of
Ice-Cream
Cones
Demand
curve, D1
Demand
curve, D2
Increase in
Demand
Demand
curve, D3
Decrease in
Demand
Quantity of Ice-Cream Cones
Any change that raises the quantity that buyers wish to purchase at any given price shifts the demand curve to the right. Any change that lowers the quantity that buyers wish to purchase at any given price shifts the demand curve to the left.

17. Demand Variables that can shift the demand curve Income
Prices of related goods
Tastes
Expectations
Number of buyers

18. Demand Income Normal good Inferior good Other things constant
An increase in income
Increase in demand
Inferior good
Decrease in demand

19. Demand Prices of related goods Substitutes - two goods
An increase in the price of one
Leads to an increase in the demand for the other
Complements – two goods
Leads to a decrease in the demand for the other

20. Demand Tastes Expectations - about the future (income, prices)
Change in tastes – changes the demand
Expectations - about the future (income, prices)
Affect current demand
Number of buyers – increase
Market demand - increases

21. Table 4.1 Factors That Shift the Demand Curve

22. Two ways to reduce the quantity of smoking demanded
Shift the demand curve for cigarettes and other tobacco products
Public service announcements
Mandatory health warnings on cigarette packages
Prohibition of cigarette advertising on television
If successful
Shift demand curve to the left

23. Two ways to reduce the quantity of smoking demanded
Try to raise the price of cigarettes
Tax the manufacturer
Much of tax – passed to consumers (high prices)
Movement along demand curve
10% increase in price → 4% decrease in smoking
Teenagers: 10% increase in price → 12% decrease smoking
Demand for cigarettes vs. demand for marijuana
Appear to be complements

24. Shifts in demand curve vs. movements along demand curve4
Shifts in demand curve vs. movements along demand curve
(a) A Shift in the Demand Curve
(b) A Movement along the Demand Curve
Price of
Cigarettes,
per Pack
A policy to discourage smoking shifts the demand curve to the left
Price of
Cigarettes,
per Pack
A tax that raises the
price of cigarettes
results in a movement
along the demand curve D1 D1 D2
$4.00 C 12 B A
$2.00
2.00 10 20 A 20
Number of Cigarettes Smoked per Day
Number of Cigarettes Smoked per Day
If warnings on cigarette packages convince smokers to smoke less, the demand curve for cigarettes shifts to the left. In panel (a), the demand curve shifts from D1 to D2. At a price of $2.00 per pack, the quantity demanded falls from 20 to 10 cigarettes per day, as reflected by the shift from point A to point B. By contrast, if a tax raises the price of cigarettes, the demand curve does not shift. Instead, we observe a movement to a different point on the demand curve. In panel (b), when the price rises from $2.00 to $4.00, the quantity demanded falls from 20 to 12 cigarettes per day, as reflected by the movement from point A to point C.

25. Supply Quantity supplied Law of supply Amount of a good
Sellers are willing and able to sell
Law of supply
Other things equal
When the price of the good rises
Quantity supplied of a good rises

26. Supply Supply schedule - a table Supply curve - a graph
Relationship between
Price of a good
Quantity supplied
Supply curve - a graph
Individual supply
Supply of one seller

27. Ben’s supply schedule and supply curve5
Ben’s supply schedule and supply curve
$3.00
2.50
2.00
1.50
1.00
0.50
Price of
Ice-Cream
Cones
Supply curve
Price of
Ice-cream cone
Quantity of
Cones supplied
$0.00
0.50
1.00
1.50
2.00
2.50
3.00
0 cones 1 2 3 4 5
1. An increase
in price . . .
increases quantity
of cones supplied. 12 10 11 9 1 2 3 4 5 6 7 8
Quantity of Ice-Cream Cones
The supply schedule is a table that shows the quantity supplied at each price. This
supply curve, which graphs the supply schedule, illustrates how the quantity supplied
Of the good changes as its price varies. Because a higher price increases the quantity supplied, the supply curve slopes upward.

28. Supply Market supply Market supply curve
Sum of the supplies of all sellers for a good or service
Market supply curve
Sum - individual supply curves horizontally
Total quantity supplied of a good varies
As the price of the good varies
All other factors that affect how much suppliers want to sell are hold constant

29. Market supply as the sum of individual supplies (supply schedule)6
Market supply as the sum of individual supplies (supply schedule)
Price of ice-cream cone
Ben
Jerry
Market
$0.00
0.50
1.00
1.50
2.00
2.50
3.00 1 2 3 4 5 + 6 8 = 7 10 13
The quantity supplied in a market is the sum of the quantities supplied by all the sellers at each price. Thus, the market supply curve is found by adding horizontally the individual supply curves. At a price of $2.00, Ben supplies 3 ice-cream cones, and Jerry supplies 4 ice-cream cones. The quantity supplied in the market at this price is 7 cones

30. Market supply as the sum of individual supplies6
Market supply as the sum of individual supplies
Ben’s
supply +
Jerry’s
supply =
Market
supply
$3.00
2.50
2.00
1.50
1.00
0.50
Price of
Ice
Cream
Cones
$3.00
2.50
2.00
1.50
1.00
0.50
Price of
Ice
Cream
Cones
$3.00
2.50
2.00
1.50
1.00
0.50
Price of
Ice
Cream
Cones
SBen
SMarket
SJerry 12 10 11 9 1 2 3 4 5 6 7 8
Quantity of Ice-Cream Cones 1 2 3 4 5 6 7
Quantity of
Ice-Cream Cones 18 2 4 6 8 10 12 14 16
Quantity of Ice-Cream Cones

31. Supply Shifts in supply Increase in supply Decrease in supply
Any change that increases the quantity supplied at every price
Supply curve shifts right
Decrease in supply
Any change that decreases the quantity supplied at every price
Supply curve shifts left

32. Shifts in the supply curve7
Shifts in the supply curve
Price of
Ice-Cream
Cones `
Supply
curve, S3
Supply
curve, S1
Supply
curve, S2
Decrease in
supply
Increase in
Supply
Quantity of Ice-Cream Cones
Any change that raises the quantity that sellers wish to produce at any given price shifts the supply curve to the right. Any change that lowers the quantity that sellers wish to produce at any given price shifts the supply curve to the left.

33. Supply Variables that can shift the supply curve Input Prices
Supply – negatively related to prices of inputs
Technology
Advance in technology – increase in supply
Expectations about future
Affect current supply
Number of sellers – increase
Market supply - increase

34. Table 4.2 Factors That Shift the Supply Curve

35. Supply and Demand Together
Equilibrium - a situation
Market price has reached the level :
Quantity supplied = quantity demanded
Equilibrium price - the price:
Balances quantity supplied and quantity demanded
Equilibrium quantity
Quantity supplied and the quantity demanded at the equilibrium price

36. The equilibrium of supply and demand8
The equilibrium of supply and demand
$3.00
2.50
2.00
1.50
1.00
0.50
Price of
Ice-Cream
Cones
Supply
Demand
Equilibrium
price
Equilibrium
Equilibrium
quantity 12 10 11 9 1 2 3 4 5 6 7 8
Quantity of Ice-Cream Cones
The equilibrium is found where the supply and demand curves intersect. At the equilibrium price, the quantity supplied equals the quantity demanded. Here the equilibrium price is $2.00: At this price, 7 ice-cream cones are supplied, and 7 ice-cream cones are demanded.

37. Supply and Demand Together
Surplus
Quantity supplied > quantity demanded
Excess supply
Downward pressure on price
Shortage
Quantity demanded > quantity supplied
Excess demand
Upward pressure on price

38. Markets not in equilibrium9
Markets not in equilibrium
(a) Excess Supply
(b) Excess demand
Price of
Ice
Cream
Cones
Price of
Ice
Cream
Cones
Supply
Supply
Surplus
Demand
Demand
$2.50 4
Quantity
demanded 10
Quantity
supplied
2.00
$2.00 7 7
1.50 4
Quantity
supplied 10
Quantity
demanded
Shortage
Quantity of Ice-Cream Cones
Quantity of Ice-Cream Cones
In panel (a), there is a surplus. Because the market price of $2.50 is above the equilibrium price, the quantity supplied (10 cones) exceeds the quantity demanded (4 cones). Suppliers try to increase sales by cutting the price of a cone, and this moves the price toward its equilibrium level. In panel (b), there is a shortage. Because the market price of $1.50 is below the equilibrium price, the quantity demanded (10 cones) exceeds the quantity supplied (4 cones). With too many buyers chasing too few goods, suppliers can take advantage of the shortage by raising the price. Hence, in both cases, the price adjustment moves the market toward the equilibrium of supply and demand

39. Supply and Demand Together
Law of supply and demand
The price of any good adjusts
Bring the quantity supplied and the quantity demanded into balance
In most markets
Surpluses and shortages are temporary

40. Supply and Demand Together
Three steps to analyzing changes in equilibrium
Decide: the event shifts the supply curve, the demand curve, or both curves
Decide: curve shifts to right or to left
Use supply-and-demand diagram
Compare initial and new equilibrium
How the shift affects equilibrium price and quantity

41. Supply and Demand Together
Example: A change in market equilibrium due to a shift in demand
One summer - very hot weather
Effect on the market for ice cream?
Hot weather - demand curve (tastes )
Demand curve shifts to the right
Higher equilibrium price; higher equilibrium quantity

42. How an increase in demand affects the equilibrium10
How an increase in demand affects the equilibrium
Price of
Ice-Cream
Cones
Supply
Hot weather
increases the demand
for ice cream . . . D2
2. …resulting in
a higher price . . . D1
$2.50
New equilibrium 10
2.00 7
Initial equilibrium
3. …and a higher quantity sold.
Quantity of Ice-Cream Cones
An event that raises quantity demanded at any given price shifts the demand curve to the right. The equilibrium price and the equilibrium quantity both rise. Here an abnormally hot summer causes buyers to demand more ice cream. The demand curve shifts from D1 to D2, which causes the equilibrium price to rise from $2.00 to $2.50 and the equilibrium quantity to rise from 7 to 10 cones

43. Supply and Demand Together
Shifts in curves versus movements along curves
Shift in the supply curve
Change in supply
Movement along a fixed supply curve
Change in the quantity supplied
Shift in the demand curve
Change in demand
Movement along a fixed demand curve
Change in the quantity demanded

44. Supply and Demand Together
Example: A change in market equilibrium due to a shift in supply
One summer - a hurricane destroys part of the sugarcane crop
Price of sugar - increases
Effect on the market for ice cream?
Change in price of sugar - supply curve
Supply curve - shifts to the left
Higher equilibrium price; lower equilibrium quantity

45. How a decrease in supply affects the equilibrium11
How a decrease in supply affects the equilibrium
Price of
Ice-Cream
Cones
1. An increase in the
price of sugar reduces
the supply of ice cream . . . S2
2. …resulting in
a higher price . . .
Demand S1
$2.50
New equilibrium 4
2.00 7
Initial equilibrium
3. …and a smaller quantity sold.
Quantity of Ice-Cream Cones
An event that reduces quantity supplied at any given price shifts the supply curve to the left. The equilibrium price rises, and the equilibrium quantity falls. Here an increase in the price of sugar (an input) causes sellers to supply less ice cream. The supply curve shifts from S1 to S2, which causes the equilibrium price of ice cream to rise from $2.00 to $2.50 and the equilibrium quantity to fall from 7 to 4 cones

46. Supply and Demand Together
Example: shifts in both supply and demand
One summer: hurricane and heat wave
Heat wave – shift demand curve; hurricane – shift supply curve
Demand curve shifts to the right; Supply curve shifts to the left
Equilibrium price raises
If demand increases substantially while supply falls just a little: equilibrium quantity –rises
If supply falls substantially while demand rises just a little: equilibrium quantity falls

47. A shift in both supply and demand12
A shift in both supply and demand
Price of
Ice
Cream
Cones
(a) Price Rises, Quantity Rises
Price of
Ice
Cream
Cones
(b) Price Rises, Quantity Falls S2
Small
increase
in demand
New
equilibrium D2 S2
Large
increase
in demand S1 S1
New
equilibrium D2 D1 P2 P2 D1 Q2 Q2
Large
decrease
in supply
Small
decrease
in supply P1 P1
Initial
equilibrium Q1 Q1
Initial
equilibrium
Quantity of Ice-Cream Cones
Quantity of Ice-Cream Cones
Here we observe a simultaneous increase in demand and decrease in supply. Two outcomes are possible. In panel (a), the equilibrium price rises from P1 to P2, and the equilibrium quantity rises from Q1 to Q2. In panel (b), the equilibrium price again rises from P1 to P2, but the equilibrium quantity falls from Q1 to Q2.

48. What happens to price and quantity when supply or demand shifts?4
What happens to price and quantity when supply or demand shifts?
No change
In Supply
An increase
A decrease
In supply
In demand
P same
Q same
P up
Q up
P down
Q down
P ambiguous
P Down
Q ambiguous